Sustainable Credit Growth: The Importance of Aligning Interest Rates to Economic Performance
India's microfinance sector is showing increasing signs of stress, with rising delinquency rates across unsecured lending segments. Recent data reveals concerning patterns in personal loans, credit cards, and micro-enterprise lending. Most notably, there is an increasing proportion of borrowers holding three to four concurrent loans, with total exposure often exceeding ?2 lakh – a clear indicator of mounting financial distress.
Particularly worrying is the segment with loans below ?50,000, which is experiencing the highest delinquency rates. This is particularly concerning as these smaller-ticket loans make up a large proportion of microfinance portfolios and represent critical exposure for small finance banks and MFI-focused NBFCs.
The key lies in ensuring that lending rates maintain a reasonable spread over the RBI's repo rate, with the spread width correlating to overall economic performance.
Shift Towards Secured Lending
Over the past quarter, this vulnerable segment has been pivoting towards gold loans as a safer financing alternative. Gold loans, being secured products, remain accessible even as lenders tighten the evaluation criteria for unsecured credit. Reflecting this shift, microfinance institutions specializing in gold loans are projecting growth rates of up to 20-25% this year. However, this growth trajectory is likely to moderate as small-finance banks and generic NBFCs expand into offering gold-backed loans to diversify their portfolios.
The current stress in the microfinance sector stems from unchecked growth in MFI financing over the past few years, driven by aggressive lending practices and limited risk assessments. Against this backdrop, the government has proposed the creation of a creditworthiness index for MSME lending, aiming to make financing more accessible to small and micro enterprises in the country.
While different loan segments may be priced differently within this band based on risk profiles, the total spread should not widen during periods of declining GDP growth.
Balancing Lending Rates with Economic Growth
However, while improving MSME funding access is crucial for economic growth, the interest rate environment demands careful consideration. With GDP growth moderating to 6.7% in Q2 2024 from 8.2% in the previous year, and the RBI still maintaining a hawkish tone* despite a change to neutral stance (on rates), extending high-cost credit to this sector could potentially seed future asset quality issues.
The key lies in ensuring that lending rates maintain a reasonable spread over the RBI's repo rate, with the spread width correlating to overall economic performance. While different loan segments may be priced differently within this band based on risk profiles, the total spread should not widen during periods of declining GDP growth. This approach would help maintain credit availability while preventing the build-up of systemic risks.
In upcoming posts, we will explore the parameters proposed for the government's MSME creditworthiness score and analyze the pros and cons of lending based on this metric.