Farm loan waiver to hit banks more; No impact on MFIs and NBFCs, says Morgan Stanley report
The recent announcement by two state governments on farm loan waiver will affect banks more compared with micro-finance institutions (MFIs) and non-banking finance companies (NBFCs), says a research report. The state governments of Uttar Pradesh announced a farm loan waiver in April and Maharashtra announced one in June.
In a note, Morgan Stanley says, "These loan waivers apply only to loans by banks which in due course will get compensated by the respective state governments. However, the concern is risk of 'moral hazard' or wilful defaults by borrowers. We agree with the moral hazard risk from rural lending for lenders and will need to wait and see how it affects second order non-performing loan (NPL) formation. However, in our view, the impact is likely to be greater for banks with large unsecured farm loans and less for secured loans or joint liability group (JLG) lending."
According to the report, investors are concerned about the risk of higher loan defaults at MFIs and NBFCs with rural exposure owing to recent farm loan waivers and demand for waivers in more states. There are news reports of demands for loan waivers by farmers in more states – some of them being Tamil Nadu, Haryana, Punjab, Madhya Pradesh, Gujarat and Karnataka.
"We will know the exact impact of farm loan waivers on these businesses only with a lag," Morgan Stanley says, adding, "management commentary and initial data points suggest no material impact till now."
Feedback from these companies suggests that while farm loan waivers are bad for credit culture and may 'intuitively' appear bad for business; historically there has been little negative impact. "Their experience suggests that what hurts collections is disruption of operations (from events like demonetisation) rather than farm loan waiver. As Per Bharat Financial Inclusion, earlier known as SKS Microfinance (BHAFIN), its collections continued to improve even following the Uttar Pradesh loan waiver announcement in April. The management of Mahindra and Mahindra Financial Services Ltd (MMFS) also saw no meaningful impact from the previous farm loan waiver in 2009. Management attributes this to awareness among borrowers regarding applicability of farm loan waivers and the option with MMFS to repossess the vehicle in the event of default," the report added.
Morgan Stanley, while explaining why it had remained over weight on BHAFIN, says, its numbers screen much better than rest of the industry. Rural microfinance has also done much better than urban microfinance during demonetisation, as credit bureau data suggest.
As of March 2017, BHAFIN’s 30-day overdue ratio was 7.4% compared with 14.1% for the MFI industry; its 90-day overdue ratio was 4.0% as against 8.2%. As per the company management, the difference stems from the company's weekly collection model and focus on rural microfinance against urban microfinance, which is more crowded. For BHAFIN 79% is rural and 21% is urban; while for the MFI industry, 53% was urban vs. 33% about four years ago.
According to Morgan Stanley, rural economic indicators in India are looking good. It says, "...rural government spending was up about 24% in FY2017 and is budgeted to increase another 10% in FY2018. Also, monsoon is expected to be near normal for a second consecutive year after two years of drought. Rural wage growth has been rising and tractor and two-wheeler sales have rebounded sharply from demonetisation lows."
Expressing concern over the demand for farm loan waiver from more states, the report feel it is still premature to build in higher loan losses for BHAFIN than its current assumptions. "BHAFIN management has mentioned that collections have been improving across states. We are working with the assumption that borrowers who did not default amid demonetisation and political instigation are unlikely to break credit discipline because of farm loan waivers. Having said that, BHAFIN's loan exposures to states where there is a demand for farm loan waivers are – Tamil Nadu (0%), Madhya Pradesh (3.8%), Punjab (1.5%), Haryana (1.8%), Gujarat (0%) and Karnataka
(12.4%). We note per management commentary, that parts of Karnataka that were affected have been showing improvement in collections," Morgan Stanley added.