The near implosion of Fusion Finance which breached covenants on Rs 5,618 crore of debt might have come as a rude shock but the troubles in microfinance have been in the making for some time now. Fusion’s provisions for stressed loans for the September quarter hit694 crore—exceeding its operating profit prompting the auditors to say it may not remain a “going concern” for much longer. About a fortnight back, the Reserve Bank of India (RBI) called out four shadow bank lenders–Navi Finserv, DMI Finance, Asirvad Microfinance, and Arohan Financial—charging them with engaging in unfair and usurious practices and violating guidelines; it barred these players from giving loans.

The Microfinance Institutions Network (MFIN) has rushed to tighten underwriting standards. Starting January 1, 2025, there can be only three lenders per borrower, not four. The outstanding loan per borrower is now capped a Rs 2 lakh and not 3 lakh. Importantly, when computing the maximum indebtedness, both MFI loans and unsecured retail loans will be included. So far, only micro-finance loans were considered to arrive at the borrower’s total debt. Again, lending to borrowers with loans overdue for more than 60 days—not 90 days as of now– must stop.

These guardrails are all very well except that they may have come a little too late to save all entities. As Ajit Kumar and Parth Desai at Nomura Global Markets Research, point out, the assets under management (AUM) for borrowers with three or more active lender associations was 35% while the number for borrowers with 4 or more lenders was 19%. “Thus, pursuant to the new guidelines, the borrower base that can be catered to by the MFI industry should shrink substantially,” they say. They also believe the guidelines should lead to higher stress in the near term. Indeed, the RBI’s directive to stop netting off loans will result in elevated slippages in the near term.

Kunal Shah and Dipanjan Ghosh at Citi Research point out that 8-10% of the industry’s AUM are linked to borrowers with four lenders. There is about 9% exposure to borrowers with five or more lenders. If that isn’t bad enough, 7% of the AUM is with customers whose microfinance debt exceeds Rs 2 lakh. “The refinancing constraint during the deleveraging phase would increase the risk of the stress spilling over,” Shah and Ghosh caution.

Indeed, NBFCs and MFI have made more than good use of RBI’s relaxed norms rolled out in April 2022 and been generous with loans. As a result of which the stress in the sector has been building up. Industry estimates suggest that if all unsecured exposure is included, the percentage of AUM/borrowers with an indebtedness of over Rs 2 lakh would be even more than 7%. The portfolio- at- risk or PAR levels for this cohort of customers is believed to high. Again, at the end of June, 2024, about 14% of borrowers was estimated to be exposed to three or more lenders while 6% of borrowers was estimated to be associated with four or more lenders. Also, by one estimate, 3.5% of the MFI portfolio consists of loans overdue by 60-180 days.

As Jiji Mammen, ED and CEO of Sa-Dhan, also a self-regulatory organisation for MFIs, acknowledges, the credit bureaus do not have data on many of the borrowers. “In some regions, borrowers have been taking loans from 4-6 lenders and struggling to repay them,’ Mammen told FE. For instance, 28-29% of Fusion Finance customers have three-plus and four-plus loans.” Anand Dama at Emkay Financial Services estimates the portfolio-at –risk at Fusion to be nearly 15% at an all-India level. The PAR for customers with three or more lenders could be higher at about 22%, Dama reckons. That’s plausible because the RBI’s rule that a household’s monthly loan obligations —principal and interest—should not exceed 50% of its monthly income—was not really followed. For one estimating rural household income was difficult since most transactions are in cash; also credit bureaus were not equipped with enough data.
To be sure, the post-Covid stress in rural households exacerbated the problem. As K Paul Thomas, MD & CEO ESAF SFB points out many households approached multiple lenders as they struggled to meet expenses. While lenders should
have assessed the situation on the ground more carefully and tightened their purse strings, many disregarded the stress signals and chose to lend more.

Abhishek Murarka and Rahil Shah, HSBC Global Research point out that between FY20 and FY22, the growth in the AUM was almost entirely reliant in the expansion in the ticket size. “This was when existing customers got repeat loans with few disbursements to new customers,” they observe.

One reason lenders were willing to lend was the temptation of what the regulator believes are “usurious” interest rates. Some banks and Non Banking Financial Companies (NBFCs) have been charging 25-28% although their cost of funds is only 6-8% leaving themselves more-than-handsome spreads.

Before the regulator eased the rules, loan rates were typically 10% over the cost-of-funds-plus. Industry insiders argue that having freed up the interest rates and allowed companies to set board-approved policies, the regulator should now not question the rates. “It’s more politically-driven now. The authorities want the poor to get unsecured loans at lower rates,” they added. That may be so. But the regulator nonetheless has a point in that interest rates are very high.
And the industry must respect this.