Demonetisation: A pause for sustainable growth of microfinance industry?
Moneylife Digital Team 08 February 2017
Post demonetisation, the profitability of domestic microfinance institutes (MFIs) is expected to be negatively impacted in the near term. However, as a positive outcome of the demonetisation, most of the MFIs are further strengthening their risk management system by checking the overleveraging of borrowers and disbursing funds on a more prudent basis, says a research report.
In the note, Credit Analysis and Research Ltd (Care Ratings), says, "In the near-term, the profitability of the Indian MFI Industry is expected to be negatively impacted mainly due to reversal of income due to creation of non-performing asset (NPA), increase in cost-to-income ratio on the back of lower income as a result of expected decline in loan portfolio per employee, and increase in provisioning expense due to deterioration in the asset quality. As a result, the credit profile of the entities with concentrated portfolio (especially in affected states), high leverage and weak asset liability management is expected to remain under pressure over the next six to 12 month period."
According to the report, the Microfinance Institutions Network (MFIN) is also putting in place an initiative where all the industry players have voluntarily agreed to cap the number to three lenders per borrower, as against only two non-banking finance companies (NBFC)-MFI per borrower but with no cap on other lenders, by increasing the universe from NBFC-MFIs to cover the entire industry like banks, small finance banks (SFBs), NBFCs, NBFC-MFIS, Section 8 or Section 25 companies as defined in the Companies Act. This would help in better management of overall indebtedness of the borrowers from the industry perspective, Care Ratings added.
Care Ratings interacted with a few major MFIs, which felt that collection efficiency was expected to improve in the month of January 2017 due to improved supply of new currency, general improvement in economic activity and important role played by self-regulatory organisation (SRO) in creating awareness among the borrowers directly or indirectly through bureaucrats and sustained media engagements. 
It says, "While the industry expects collection efficiency to reach to normal level by June 2017, continued interference of local influential individuals with mala fide intention remains a major risk to the sector in the near-term. However, the collection efficiency is expected to reach to normal levels over the medium-term period due to increased credit disciple among the borrowers as a result of presence of credit bureaus."
Demonetisation has also given a sudden push to the MFI sector to move towards cashless mode of operation. While Care Ratings says it believes that a good proportion of MFI transaction would continue to be dependent upon cash mode due to low penetration of banks/ATM in rural areas, most of the borrowers are at the bottom of the pyramid, which are dealing only in cash and low proportion of smartphone users in India, especially women. However, the intention of most of the MFI’s to shift the business to cashless mode would bring in greater transparency and enhance the risk management system over the medium-term perspective, it added.
To assess the near-term impact of demonetization on Indian MFIs, Care Ratings conducted a survey with 32 MFI entities and one SRO (Sa-dhan). The MFI entities has been categorized as large MFIs (10 with gross loan portfolio-GLP of more than Rs500 crore), mid-size MFIs (11 with GLP of Rs100-Rs500 crore) and small-size MFI (11 with GLP lower than Rs100 crore). The participants in the survey include top-level executives. The combined asset under management (AUM) of the surveyed participants was estimated to be around Rs34,000 crore, accounting for roughly 42% of total MFI industry.
Care Ratings says, a majority of the respondents were of the view that the demonetisation would have a negative impact on the Indian MFI industry in the short term, but the magnitude of the impact would not be as severe as witnessed during the Andhra Pradesh crisis period mainly due to increased regulatory intervention of Reserve Bank of India (RBI), presence of credit bureaus and SROs and self-imposition of stricter code of conduct by MFIN on members than required by RBI. MFIN members account for about 80% of Indian Microfinance industry.
Roughly, 88% of the respondents expect collection rate to improve to more than 90% by March 2017, which indicates a sharp improvement in collection compared to the level achieved in the past two months at around 80%. Further, all the participants are of the view that the collection efficiency is expected to reach to the level of pre-demonetisation period, or around 99% by June 2017, it added. 
According to the Survey, roughly 72% of the respondents will avail the relaxation benefit provided by RBI for asset classification norms by additional period of 90 days for the loan instalments falling due from 1 November 2016 to 31 December 2016. Further, almost all the respondents are of the view that the projected growth of loan portfolio in FY18 has been revised down due to slowdown in disbursement after demonetisation. 
Based on interaction with major MFI entities, Care Ratings says it believes that the decline in AUM growth is mainly due to lower disbursement from banks, NBFCs and financial institutes (FI)’s on the back of cautious stance on the sector, delay or disruption in equity raising plan of the company due to investors becoming cautious on the sector and higher focus of the MFI entities to improve collection efficiency and maintenance of higher liquidity cushion in the system.
Around 66% of the respondents are of the view that the demonetization would have structurally positive impact on the Indian MFI industry over the medium-term as most of the entities would gradually shift their business from cash mode to cashless mode, Care Ratings concluded.
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