‘TN, Karnataka ordinances to hinder MFI recovery; poll-bound Bihar under watch’

new delhi: Microlenders are unlikely to turn profitable before the end of the current fiscal, a domestic rating agency said on Wednesday.

Crisil Ratings said the ordinances pushed by Karnataka and Tamil Nadu pertaining to microfinance institutions’ (MFIs) operations in the state could “hinder” the recovery path for the sector.

Lenders have been facing asset quality challenges in the MFI segment for over a year, largely due to over-leveraged borrowers. To address these issues, they have capped the number of lenders per borrower and emphasised that microfinance is a cyclical business that will eventually recover.

“The path to revival for microfinance institutions is expected to be a challenging one with normalisation of profitability expected only by the end of the current fiscal,” the rating agency note said.

It said even though the industry has put guardrails from April 1, legacy assets will continue to haunt and keep the asset quality under pressure.

“Furthermore, disruptions caused by ordinances pertaining to microfinance operations in Karnataka and Tamil Nadu could hinder the path to recovery,” it said.

The agency said the two states account for a fourth of the overall MFI portfolio, and added that the poll-bound Bihar, which contributes 15 per cent of the portfolio, is also a monitorable.

The ordinance promulgated in Tamil Nadu recently and effective from June 9 is akin to the one in Karnataka, the agency said, adding that it will determine how portfolio quality evolves in the state.

In the case of Karnataka, while the decline in collections after the ordinance has been “stanched”, the overall collections at 80-85 per cent for the past few months are well below historic levels.

“The Bihar portfolio remains under watch as well, given the state goes to polls in the third quarter of the current fiscal. In the past, sociopolitical issues have impacted collections during polls in some states,” it added.

The agency’s director Malvika Bhotika said collection efficiencies have stabilised at 98-99 per cent for the sector, and there has been some reduction in the slippages as well.

Bhotika said around 14 per cent of the assets under management (AUM) as on June 30, 2025, remain extended to borrowers transacting with more than three microfinance lenders, adding that this has reduced from 23 per cent in December 2024.

Adoption of the guardrails makes this portfolio “very vulnerable” to slippages as borrowers will not always be able to manage fresh funding to pay off their debt commitments, Bhotika said.

Given this, credit costs for the sector are expected to reduce to 6 per cent in FY26 from 7.7 per cent in FY25, its associate director Prashant Mane said, adding that overall profitability is likely to normalise only by the fourth quarter of this fiscal.

Healthy capital position and adequate liquidity at well-rated entities are the two pillars of strength for entities in the sector, the agency said.

The ability of MFIs to control slippages and navigate state-level issues will bear watching, it added.