India's specialty lenders that serve the smallest borrowers have achieved a scale and reach that will allow them to grow rapidly over the coming years, helped by technology that lets them manage costs more efficiently, according to a Nomura report.
Microfinance institutions, despite facing higher risks, have become a "meaningfully large segment" in the world's second-biggest country by population, Nomura said in a Dec. 11 report titled: Microfinance – the next decade of opportunity.
The segment, where individual loans can be lower than $250, has grown at an annual rate of 23% over the last eight years to reach an asset size of 3.4 trillion rupees. It is now one of the biggest retail segments after mortgages and is among the best performing among nonbank financial companies, many of which still face challenges.
Nomura estimates that penetration levels by Indian microfinance lenders such as CreditAccess Grameen Ltd., the Indian unit of CreditAccess Asia NV, Ujjivan Financial Services Ltd. and Equitas Holdings Ltd. have improved to about 38% of the addressable market now, from under 18% eight years ago.
"We see a sustainable growth opportunity in this segment with penetration levels likely to improve further, especially in the rural segment," the brokerage said.
India's rural areas have shown greater resilience amid the COVID-19 pandemic. Urban centers, usually with higher population density, bore the brunt of the disease. The government's incentive plans to help the economy recover from the blow — the nation slipped into its first recession on record this year — have also focused on the poorest segments of the population, for whom microfinance lenders are often the only option to get funding.
Nomura expects the rural segment to drive growth for the microfinance sector over the next decade, as cost efficiencies and investments in digital initiatives help the lenders reach more potential customers. Better borrower information from local credit bureaus, higher regulatory limits on ticket sizes of loans and the lenders' familiarity with their customers will help, too.
A large number of microfinance institutions have converted into banks in the last five years, which will help bring funding stability to the sector, according to the report.
Deposits have also been rising, providing these lenders with a steady source of cheaper funds. "We see this as a clear game-changer for the industry given funding shocks will likely get meaningfully minimized in the sector," Nomura said, adding that Indian microfinance companies are among the most efficient in the world.
The Japanese brokerage is advising its clients to buy CreditAccess, Equitas, Ujjivan and Bandhan Bank Ltd., saying that "microfinance still presents a huge growth opportunity over the next decade."
Still, microfinance remains a high-risk segment, Nomura said, citing several events such as political developments and natural calamities in the past that drove the costs of credit and nonperforming assets higher.
"Most of the recent credit events have been more politically inflicted while ultimate credit loss from natural calamities have been limited," it said, adding: "We see concentration risks to be one of the key risks in microfinance." The sector has suffered in the past from political interference, with rival political parties sometimes encouraging borrowers to willfully default, it noted.
Microfinance also has a lower entry barrier, which has seen several private equity-backed lenders chasing the high growth and returns that the segment offers, it said, advising clients to stick to the more "disciplined players" that have learnt from their past mistakes.
As of Dec. 15, US$1 was equivalent to 73.54 Indian rupees.