OREANDA-NEWS. Rising exposure to microfinance at Sri Lankan non-bank financial institutions (NBFIs) could pose a risk to their credit profiles, says Fitch Ratings. The exposure among Fitch-rated NBFIs stood at just 4% of total loans of these entities as recently as March 2014. but this had increased to 27% by December 2015.

Fitch estimates that loan-book exposure to microfinance accounted for about 30% of loans at end-March 2015 at 10 listed NBFIs. Micro-finance lending among Fitch-rated NBFIs takes the form principally of lending to an individual who is part of a small group, with the rest of the group members cross-guaranteeing the loans in the event of default. Lending is generally in small amounts, and is used to support income-generating activity. It involves uncollateralised lending to a customer segment that is usually characterised as of low income and with limited access to formal financial services. Consequently, Fitch believes that lending to this segment is likely to be more susceptible to asset-quality deterioration during periods of economic stress.

Furthermore, Sri Lanka continues to lack a comprehensive regulatory and supervisory system for the microfinance sector. As a result, many of the large number of institutions engaged in the provision of microfinance are unregulated. Efforts to introduce such regulations have been ongoing for many years, including the passing of a microfinance bill. Fitch maintains that the passage of prudential regulatory requirements on microfinance entities should be positive for the financial sector.

Fitch-rated NBFIs have made efforts to manage the risk of their significant exposures to microfinance through product structuring, regular collections and close contact with borrowers. Lending rates on microfinance are also generally high, due to the greater credit risk of this type of lending.

Nonetheless, the rising exposure to microfinance points to increased risk for NBFIs, especially during a period when operating conditions could become more challenging for the financial sector as a whole. Fitch expects Sri Lanka's real GDP growth to remain relatively high at above 5% through 2017. But the outlook for the financial sector is largely dependent on the operating environment, and volatility remains a key risk in the economy. Notably, Fitch downgraded the sovereign to 'B+' in March with a Negative Outlook.