Capital crunch, poor asset quality topple small microfinance institutions – The Economic Times

Report on the Microfinance Sector Crisis in India and its Implications for Sustainable Development Goals

Executive Summary

A significant crisis is unfolding within India’s microfinance sector, with multiple Non-Banking Finance Company-Microfinance Institutions (NBFC-MFIs) defaulting on bank loans. This situation, driven by prolonged asset quality stress and a severe funding crunch, poses a direct threat to the survival of smaller, under-capitalised lenders. The instability of these institutions, which are crucial for financial inclusion, has profound negative implications for India’s progress towards several key Sustainable Development Goals (SDGs), particularly SDG 1 (No Poverty), SDG 5 (Gender Equality), SDG 8 (Decent Work and Economic Growth), and SDG 10 (Reduced Inequalities).

Analysis of the Sectoral Crisis

The distress in the microfinance sector is attributed to a combination of factors that have been escalating for over six quarters. The core challenges jeopardizing the sector’s contribution to sustainable development include:

• Asset Quality Degradation: The ratio of portfolios at risk over 180 days, including write-offs, surged to 15.32% at the end of the September quarter, indicating severe legacy stress.
• Funding and Liquidity Shortage: Small and medium-sized MFIs are facing an acute liquidity crunch, making operations difficult without immediate institutional funding support.
• Market Contraction: India’s micro-loan market has contracted by 17% year-on-year to ₹3.46 lakh crore, with a corresponding 20% decline in active loans.
• Profitability Hits: Both listed MFIs and mainstream banks with microfinance portfolios have reported net losses and reduced profitability due to higher credit costs.

Impact on Sustainable Development Goals (SDGs)

The failure of microfinance institutions directly undermines national efforts to achieve the SDGs by 2030.

1. SDG 1 (No Poverty): MFIs are a primary vehicle for providing financial services to low-income households. Their collapse removes a critical lifeline for the poor, hindering poverty alleviation efforts and pushing vulnerable families further into poverty.
2. SDG 8 (Decent Work and Economic Growth): By financing micro-enterprises, MFIs foster entrepreneurship and local job creation. The current funding crisis stifles this engine of inclusive economic growth, limiting opportunities for decent work.
3. SDG 10 (Reduced Inequalities): Microfinance is a key tool for financial inclusion, bringing marginalized communities into the formal financial system. The instability of MFIs threatens to reverse these gains, thereby exacerbating financial and social inequalities.
4. SDG 5 (Gender Equality): A significant portion of microfinance borrowers are women, for whom access to credit is a powerful tool for economic empowerment. The sector’s decline disproportionately affects women entrepreneurs, representing a setback for gender equality.

Case Studies of Distressed Institutions

Several institutions exemplify the widespread nature of the crisis:

• VFS Capital: One of India’s oldest MFIs, it has defaulted on repayments, with total overdue amounts reaching ₹82 crore.
• Navachetana Microfin Services: The company has delayed debt servicing since April and has submitted a debt restructuring plan to its 19 lenders.
• Arth Finance: Its long-term rating was downgraded to the default category in April.
• Inditrade Microfinance: Its ratings were downgraded to junk in October of the previous year due to its financial health.

Recommendations for Sustainable Recovery Aligned with SDG 17 (Partnerships for the Goals)

Addressing this crisis requires a collaborative approach, reflecting the principles of SDG 17. To restore the sector’s stability and ensure its continued contribution to the SDGs, the following actions are recommended:

• Strengthened Institutional Partnerships: Banks and larger, cash-rich non-bank lenders must provide urgent funding to smaller MFIs with low capital buffers to ensure their operational continuity.
• Government-Led Support Mechanisms: A government guarantee programme should be established to facilitate lending to smaller MFIs, mitigating risk for lenders and ensuring capital flows to grassroots entrepreneurs.
• Regulatory Forbearance: Financial institutions and regulators should consider a more lenient approach to lending and compliance for smaller entities, such as extending deadlines for meeting capital requirements, to prevent widespread defaults.
• Enhanced Governance and Auditing: Lenders have rightly suggested forensic audits for institutions seeking debt restructuring. This is mandatory to ensure that defaults are due to genuine business loss and to rebuild trust within the sector.

Analysis of Sustainable Development Goals (SDGs) in the Article

1. Which SDGs are addressed or connected to the issues highlighted in the article?

1. SDG 1: No Poverty
   • The article focuses on microfinance companies that “typically serve low-income borrowers.” The failure of these institutions directly impacts the financial stability and economic opportunities of the poor, hindering efforts to eradicate poverty.
2. SDG 8: Decent Work and Economic Growth
   • Microfinance is a critical tool for fostering entrepreneurship and supporting micro- and small-sized enterprises, which are key drivers of economic growth and job creation. The “funding crunch” and “business shrinks” described in the article undermine these productive activities.
3. SDG 10: Reduced Inequalities
   • Microfinance institutions promote financial inclusion by providing loans to people who are often excluded from the traditional banking system. The crisis facing these lenders exacerbates financial inequality by cutting off a vital source of capital for vulnerable populations.
4. SDG 17: Partnerships for the Goals
   • The article highlights the dependency of smaller microfinance institutions on funding from “banks and bigger, cash-rich, non-bank lenders.” It also mentions a proposal for a “government guarantee programme,” pointing to the need for multi-stakeholder partnerships (public-private) to ensure the stability and sustainability of the microfinance sector.

2. What specific targets under those SDGs can be identified based on the article’s content?

1. Target 1.4: “By 2030, ensure that all men and women, in particular the poor and the vulnerable, have equal rights to economic resources, as well as access to… financial services, including microfinance.”
   • The article’s entire theme revolves around the crisis in microfinance institutions, which are the primary delivery mechanism of this specific financial service to the poor. The defaults and liquidity crisis directly threaten this access.
2. Target 8.3: “Promote development-oriented policies that support productive activities, decent job creation, entrepreneurship, creativity and innovation, and encourage the formalization and growth of micro-, small- and medium-sized enterprises, including through access to finance.”
   • The contraction of the micro-loan market and the difficulties faced by lenders directly impact the “access to finance” for the small entrepreneurs they serve, thereby hindering the growth of their enterprises.
3. Target 8.10: “Strengthen the capacity of domestic financial institutions to encourage and expand access to banking, insurance and financial services for all.”
   • The article details the weakening capacity of these domestic financial institutions (NBFC-MFIs), citing “asset quality stress,” “funding crunch,” and defaults. This fragility threatens their ability to provide financial services.

3. Are there any indicators mentioned or implied in the article that can be used to measure progress towards the identified targets?

1. Indicator for Target 1.4 & 8.3: Volume and reach of financial services
   • The article explicitly states that “India’s micro-loan market contracted to ₹3.46 lakh crore, registering a 17% year-on-year drop.” This is a direct quantitative indicator of reduced access to finance.
   • It also mentions a “near 20% fall in the number of active loans to 132 million,” which measures the declining reach of these financial services to individuals.
2. Indicator for Target 8.10: Stability and health of financial institutions
   • The “ratio of later-stage portfolios at risk over 180 days (including write-offs) surged to 15.32%.” This is a key financial health indicator that shows the increasing instability of the lending portfolios.
   • The number of MFIs defaulting on bank loans (e.g., VFS Capital, Navachetana Microfin Services, Arth Finance) serves as an indicator of institutional failure.
   • The mention of loans turning into “non-performing assets (NPAs)” is a standard banking indicator for asset quality stress.

SDGs, Targets, and Indicators Table

Source: m.economictimes.com