Key Points

Although new rules under the Guardrails 2.0 framework (starting April 1, 2025) have reduced MFIs' risk of lending to borrowers who are already heavily in debt, older loans are still causing problems.

The new set of Guardrails 2.0 elaborates points on Interest rate and processing fee, retains the points like on Loan repayment obligations of missing EMI loans and adds points on KYC and CIC reporting.

But, the legacy loans are putting pressure on the overall loan quality.

Furthermore, the report added that the disruptions caused by ordinances pertaining to microfinance operations in Karnataka and Tamil Nadu could hinder the path to recovery.

The ability to control slippages and manage credit costs, and thus profitability, will be crucial in the road ahead.

Malvika Bhotika, Director, Crisil Ratings, said, "While the current bucket collections have stabilised at 98-99 per cent and there has been some reduction in fresh slippages, around 14 per cent of the assets under management (AUM) as on June 30, 2025, remains extended to borrowers transacting with more than three microfinance lenders. While this has reduced from 23 per cent (of AUM) as of December 31, 2024, the portfolio remains very vulnerable to slippages, especially after the Guardrail 2.0 regime limited fresh loans from more lenders to such borrowers."

As per the rating agency, the performance of Tamil Nadu, Karnataka and Bihar -- together accounting for 43 per cent of the industry AUM -- remains monitorable.

The impact of the recent ordinance in Tamil Nadu (akin to the one in Karnataka and effective June 09, 2025) on MFIs will be key to how portfolio quality evolves in the state.

For Karnataka, while the decline in collections after the ordinance has been stanched, overall collections are in the range of 80-85 per cent for the past few months, well below historic levels. The Bihar portfolio (15 per cent of AUM) remains under watch as well given the state goes to polls in the third quarter of the current fiscal. In the past, socio-political issues have impacted collections during polls in some states.

Prashant Mane, Associate Director, Crisil Ratings, said, "Given these factors, the credit cost for MFIs, while reducing somewhat from the 7.7% seen last fiscal, is still expected to remain high at around 6.0% this fiscal. Consequently, overall profitability is likely to normalise only by fourth quarter of this fiscal."

The firm said that two key strengths still supporting microfinance institutions (MFIs) are their strong capital and enough cash reserves, especially among top-rated ones.

However, how well MFIs can manage bad loans and deal with challenges from state-level rules will be important to watch, the rating agency added.

- ANI