The Non-Banking Financial Companies-Microfinance Institutions (NBFC-MFIs) sector in India, which has experienced rapid growth in the last few years, is projected to see a significant slowdown in the financial year 2025. According to CareEdge Ratings, growth may reduce to a modest 4% in FY25, down from the sector’s high growth rates of 37% in FY23 and 28% in FY24. Several critical challenges contribute to this expected slowdown.
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Recent Growth and Current Challenges
Following the COVID-19 pandemic, the NBFC-MFI sector achieved remarkable growth, driven by increased demand for microloans. However, rising credit costs and compressed yields are now pressuring NBFC-MFIs’ profitability. These factors are expected to reduce the return on average assets (RoTA) to around 0.4% in FY25, a significant drop from 4.3% in FY24.
Rising Borrower Debt and the JLG Model Weakening
One of the sector’s key challenges is the growing indebtedness among borrowers. Many low-income individuals have taken out multiple loans, leading to over-leveraging and difficulty in repaying loans. The weakening of the Joint Liability Group (JLG) model, traditionally used by MFIs to ensure accountability through group responsibility, further complicates the situation.
The decline in center attendance has weakened peer pressure among borrowers, making it harder to maintain low default rates. This erosion of the JLG model impacts the effectiveness of loan recovery, an essential aspect of microfinance operations.
Financial Inclusion Role and Resilience
Despite operating within a vulnerable customer base, the NBFC-MFI sector has shown resilience in the face of significant challenges, such as the COVID-19 pandemic and demonetization. The sector’s recovery from these events reflects its strength and importance in promoting financial inclusion for underserved communities. It has garnered continued investor support, recognizing the sector’s crucial role in providing credit access for low-income populations.
Additional Risks: Regulatory Scrutiny and Staff Challenges
The sector is also grappling with additional risks:
- Regulatory Scrutiny: Tighter regulations around predatory pricing are likely to impact profitability.
- High Staff Turnover: This disrupts relationships with clients, affecting loan recovery efforts.
- Fraud Risks: Rising cases of fraud present operational risks.
- External Vulnerabilities: Socio-political risks and natural disasters can disrupt operations, particularly in rural areas where NBFC-MFIs operate.
My Opinion on the Future of the NBFC-MFI Sector
Given the slowdown, NBFC-MFIs will need to adapt by finding sustainable ways to reduce costs, improve operational efficiency, and strengthen customer engagement. Reinvigorating the JLG model could help restore peer accountability. Additionally, addressing staff retention and enhancing regulatory compliance are critical to maintaining investor confidence and operational stability.
Conclusion
While the NBFC-MFI sector faces a challenging period, its resilience and established role in financial inclusion mean it is likely to navigate these obstacles. A proactive approach to management and risk mitigation will be crucial to ensure its continued growth and support for underserved communities.
