Mumbai, March 19 : The outlook for microfinance institutions (MFIs) in India is improving after months of stress caused by overleveraging of borrowers, a new report said on Wednesday.

According to the report by HSBC Research, better loan collections and higher disbursements in February helped boost sentiment in the sector.

While the global brokerage firm expects a positive turnaround for MFIs in 2025, it also noted that some challenges still need to be addressed.

The report highlighted that 'X bucket' collection efficiency in most states improved to 98.5-99.5 per cent in February. 'X bucket' refers to accounts that had no overdue payments at the end of the previous month.

'X bucket' collection efficiency measures the percentage of EMIs collected from these accounts during a given month, compared to the total EMIs due from all such accounts in that period.

This improvement has also contributed to a reduction in high employee attrition rates, which had been a concern for the sector over the past year.

However, in Karnataka, a government ordinance caused significant disruptions in MFI operations in February.

The state government's proposed bill aims to completely exempt borrowers from repaying loans, including interest, taken from unlicensed and unregistered MFIs.

HSBC Research noted that individual microfinance institutions have taken steps to minimise the impact and stabilise their operations.

Looking ahead, credit costs for MFIs are expected to decline in the April-June quarter due to improving asset quality.

However, new regulations set to take effect on April 1, which cap lending to borrowers, are likely to push credit costs higher again.

However, HSBC Research believes banks with microfinance exposure have a stronger long-term growth potential.

These banks are better placed due to their improving asset quality and attractive valuations, which could lead to better returns for investors.

'Banks, with their diversified portfolios and stronger earnings resilience, are expected to be in a better position than standalone MFIs in the long run,' the report said.

/IANS