MFIs’ growth and profitability to moderate: CRISIL Malegam recommendations positive for long-term sustainability; could trigger consolidation

Mumbai, 18th January 2010 - CRISIL believes that the recently announced recommendations of the Malegam committee, if accepted by the Reserve Bank of India (RBI), will be a positive step towards enhancing stakeholder confidence in the microfinance institution (MFI) sector, a critical element for longterm sustainability of the sector. However, the recommendations, once implemented, will pose additional operating and compliance-related challenges for the MFI sector. The sector’s growth prospects and profitability will weaken, thereby leading to a possible consolidation in the industry.

The decline in the gross interest spreads of the top five MFIs is expected to be in the range of 5 to 8 per cent, over the medium term. The Malegam committee recommendations propose to provide greater clarity on the regulatory jurisdiction and framework for the MFI sector. The committee seeks to establish a new category of non-banking financial institutions (NBFCs) called NBFC-MFIs with RBI as the central regulator.

It has also proposed exempting NBFC-MFIs from the provisions of state-level money-lending acts (including the recent Andhra Pradesh bill). Furthermore, the recommendations are expected to enhance the transparency and governance practices in the sector by establishing a code of conduct, proper grievance redressal mechanisms, credit information bureaus, and enhanced disclosures.

Certain recommendations of the Malegam committee are, however, expected to pose additional operating challenges for the MFI sector over the medium term. MFIs will have to enhance the robustness of their internal systems and processes, strengthen their monitoring mechanisms, and invest in training their employees. Furthermore, the growth prospects of the MFI sector will remain subdued, especially in regions with high penetration of MFIs, because of restrictions on multiple lending, loan size, and end-usage of loans. The sector’s overall profitability is expected to weaken because of the proposed interest rate cap on individual loans and margin cap on an overall basis.

Consequently, CRISIL foresees a possible consolidation in the MFI industry with higher minimum net worth norms which will raise the entry barrier for new MFIs. Smaller MFIs will find it difficult to raise capital, given the challenges of lower growth and profitability. MFIs with stronger internal processes, higher focus on transparency and governance, and efficient operations will reap the maximum benefits.
The funding for the MFI sector is expected to revive gradually with increase in lenders’ confidence. In the near term, the relaxation of the restructuring guidelines by RBI will also provide temporary liquidity relief. In addition, the continuation of priority lending status for loans originated by NBFC-MFIs will ensure sustained availability of bank funding for the MFIs over the medium to long term.

CRISIL believes that the implementation of Malegam committee recommendations will lead to a relatively slow but sustainable growth for the MFI sector over the long term. CRISIL will continue to monitor the developments regarding the implementation of the recommendations and their impact on the credit risk profiles of the rated MFIs.

CRISIL is India's leading Ratings, Research, Risk and Policy Advisory company. CRISIL leverages its core strengths of credibility and analytical rigour to deliver opinions and solutions, that help clients mitigate and manage their business and financial risks, make markets function better, and help shape public policy. For more information, visit http://www.crisil.com

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This release was published on openPR.