Not All Growth Is Good ft. Microfinance Lending

In this story, I wanted to dive into how growth can sometimes be a stock investor’s worst enemy, especially in the lending business. You’ve probably heard how investing in fast-growing companies can make you a lot of money. Legends like T. Rowe Price and Phil Fisher made their fortunes this way.

But today, I'll show you how that’s not always true.?

When it comes to lending, fast growth can actually cause big problems. At first glance, a company giving out more loans might look like a booming business. Giving more loans means more interest earned and more profits, right? But it’s not all that simple.

Research shows that when banks grow too fast, it often leads to poor performance down the line. We’ve seen this happen in multiple credit cycles worldwide. Banks that grow rapidly tend to take on riskier loans, and while that might make the books look great for a while, things tend to fall apart when it’s time to collect those loans.

And right now, we’re seeing this play out in the Indian microfinance space.

The MFI sector has been on this fast-growth treadmill for a while now.

Between FY15 and FY22, India’s microfinance loan book grew at an annual rate of 29%. That’s faster than any other retail loan segment in the country.

At first glance, it sounds like an incredible success story. But here’s the catch: lending is like a ticking time bomb. Even if you’ve made some risky moves, everything can look fine on the surface for a while. In fact, things might even look great. But underneath, there’s a bomb you’ve planted, and it’s set to explode in the form of rising bad loans.

It looks like the bomb is about to go off in Fusion Microfinance which is one of the key players in this space. They have seen their customer base skyrocket as we would expect, but with some serious concerns.?

They are planning to make additional provision of Rs 550 crore because they expect rising bad loans.

About 24% of Fusion's borrowers now have loans from five or more lenders, and the non-performing assets for these customers are 1.5 to 2.5 times higher than borrowers who took out loans from fewer lenders. This number was around 6% a year ago.

And this isn’t just Fusion’s problem but it's a sector-wide phenomenon. Almost all major MFIs have seen a spike in bad loans and declining collection efficiencies. Across the board, GNPA ratios have increased, while collection efficiencies have dropped to as low as 96%.

This has reflected in their stock prices too. Most of them have tanked between 10 to 47% over the last 6 months and are now trading below their book value.

Why is this happening? According to Crisil Research, four major factors are playing into this crisis: over-leveraging of borrowers, debt waiver campaigns, operational challenges due to elections and heatwaves, and high employee attrition.

Out of all these, the first reason stood out the most for us.

You see, India’s microfinance industry had 15.9 crore accounts in March. Of these, 8.7 crore accounts belong to unique borrowers. This means, the rest have more than one account opened.

To give you some more perspective, between FY17 and FY24, the total microfinance loan book grew at a compound annual growth rate of around 22% but the number of unique borrowers rose by just 7%. You know what this means? More and more loans are being handed out to the same set of people. These borrowers are taking on new loans just to pay off their old ones, creating a cycle of debt and each new loan makes the debt even bigger, burying the borrower deeper.

The key takeaway here is to understand that lending is a collection business, and not a disbursement business.?

Disbursing loans is the easy part especially in a country like India, where people are hungry for credit. The hard part is collecting it. That’s what many players in the microfinance space seem to have forgotten

This is no new insight. This has happened time and time again. MFIs go through these boom cycles where they aggressively lend, thinking their book will keep growing. Then reality hits. Borrowers can’t repay, books start looking bad, and MFIs are left scrambling to recover their money. The cycle repeats every few years.

So, where does that leave us? Right now, we’re at a point where the situation is bad—but is this the worst it can get? We don’t know. But what we do know is that microfinance institutions need to act carefully. Rapid growth can’t continue unchecked, especially when it’s driven by lenders pushing loans instead of actual demand. If MFIs don’t slow down and focus on collection rather than disbursement, things are bound to get worse.