Microloan Woes: Stress Continues for Small Finance Banks

The microfinance sector, once viewed as a beacon of opportunity for small finance banks, has turned into a significant obstacle for institutions like ESAF, Suryoday, and Utkarsh. The evolving narrative suggests that nearly a fifth of their microloan books are under stress, risking their profitability and highlighting vulnerabilities in their operations.

Underlying Challenges in Microfinance

For these banks, the microfinance business has continued to be a major drag, especially when considering the significant portion of their loans—around 20%—that are currently delinquent. New loans might show improved repayment, but the burden of legacy loans could weigh heavily on the banks’ performance throughout the fiscal year. As noted by a rating agency, the September quarter may reveal more about the strain on ESAF and Utkarsh’s profitability due to declining asset quality and inflated credit costs.

Risk Factors and Financial Ramifications

Data from Sa-Dhan, a reputable self-regulator in the microfinance industry, provides a clearer picture. For instance, ESAF, Suryoday, and Utkarsh face alarming 30-day portfolio-at-risk (PAR) rates of 19.73%, 22.76%, and 23.23% respectively, massively affecting asset quality. The high percentage of unsecured microloans—ranging between 45-55%—is chiefly responsible for this precarious state. Adding to the challenges, the Reserve Bank of India’s increase in risk weight on such exposures to 125 basis points only intensifies the pressure.

Strategic Moves Amid Pressure

Suryoday’s strategy aims for a balanced exposure with a 50:50 secured-unsecured loan ratio and relies heavily on the Credit Guarantee Fund for Micro Units Scheme. Meanwhile, ESAF opted for drastic measures, selling ₹362 crore worth of loans and writing off ₹371 crore in the June quarter to mitigate the damage. However, both ESAF and Utkarsh reported losses, reflecting on their earnings profiles affected by degrading asset quality.

Rating Challenges and Downgrades

The intensity of the situation is further underscored by recent downgrades from rating agencies. CARE Ratings reduced ESAF’s Tier 2 bonds, while ICRA took similar action against Utkarsh’s debt programme. Such evaluations emphasize the heightened scrutiny and risk that these banks presently face.

Indicators of Strain: NPAs and Growth Control

Gross and net NPA ratios provide an evidential view into the ongoing struggles. Utkarsh’s gross NPA rose to 11.4% recently, representing a stark increase, with ESAF not far behind at 7.48%. The mounting figures reveal a stressed credit environment within these financial institutions, which could affect their growth trajectories if unresolved.

Despite these challenges, the silver lining might be in new loan distributions showing better repayment records. This shift indicates potential strategies these banks could adopt to turn the tide and restore some level of financial robustness. According to The Economic Times, resolving these ingrained microloan issues could prove integral for the broader sector’s stability in the future.