Microfinance Focus May 11, 2011: Credit ratings and research agency CRISIL recently said in a statement that growth prospects for microfinance institutions (MFIs) in India will remain subdued over the medium term.

“Operating challenges arising from the Reserve Bank of India’s (RBI’s) recently issued guidelines for MFIs, coupled with expected difficulty in raising capital, are likely to trigger consolidation in the sector,” said the ratings agency adding, “However, RBI’s guidelines should ease pressure on MFIs’ profitability, as it has relaxed some onerous recommendations of the Malegam committee.”

Furthermore, the continuation of priority-sector status and steps to enhance transparency and governance should improve stakeholder confidence and enable resumption of bank funding said CRISIL. Clarity on regulatory jurisdiction for MFIs is also a critical next step for long-term sustainability of the sector.

Rupali Shanker, Head of CRISIL Ratings said, “The MFI sector’s growth is likely to remain subdued over the medium term, especially in regions with high microfinance penetration, because of proposed regulatory restrictions on multiple lending, loan size, and end-usage of loans. This will provide an impetus for consolidation in the sector.”

According to CRISIL in order to comply with the new regulations, MFIs will have to enhance the robustness of their internal systems and processes, strengthen their monitoring mechanisms, and invest in training their employees.

Shanker also added, “CRISIL also expects RBI’s recent guidelines to provide cushion to MFIs’ profitability, and enable resumption of bank funding to MFIs.”

According to CRISIL, RBI’s guidelines are largely based on the Malegam committee recommendations, with some modifications: RBI has allowed a higher cap on interest rates and margin (of 26 per cent and 12 per cent respectively) and has clearly defined the manner of computation for these caps. RBI has also increased the limits on annual income of borrower households, enhanced the maximum ticket size of loans, allowed a higher limit on indebtedness of borrowers, and reduced the minimum threshold to qualify as an MFI. Moreover, RBI has retained the priority-sector status for bank loans to MFIs, a critical enabler of resource flows to the sector.

Further CRISIL also stated that financial risk profiles of MFIs with significant operations in Andhra Pradesh are likely to remain under considerable stress because of continued low collection rates, liquidity pressures, and expectation of substantially high credit costs over the medium term. Substantial improvement in recovery rates and timely restructuring of these MFIs’ bank loans will be critical for their survival.

CRISIL will continue to monitor developments in the MFI sector and their impact on the credit risk profiles of the entities rated by it.